Dynamic efficiency

Dynamic efficiency is a term in economics, which refers to an economy that appropriately balances short run concerns (static efficiency) with concerns in the long run (focusing on encouraging research and development).^[1]

Dynamic efficiency in the Solow Growth model

An economy in the Solow Growth model is considered dynamically inefficient, if the savings rate is greater than the Golden Rule savings rate. If the savings rate is greater than the Golden Rule savings rate, a decrease in the savings rate will increase consumption per effective unit of labor. A savings rate higher than the Golden Rule savings rate implies that an economy could be better off today and tomorrow by saving less. ^[2]

Dynamic efficiency in other models

The Ramsey-Cass-Koopmans model does not have dynamic efficiency problems because agents discount the future at some rate β which is less than 1, and their savings rate is endogenous. Graphically, the steady state line is to the left of the hump of the k dot locus.

The Diamond Growth model is not necessarily dynamically efficient because of the overlapping generation setup; there could be an allocation point, which is better than the competitive equilibrium allocation point, i.e. the equilibrium can be Pareto inefficient. This is because of a finite number of agents. ^[3]

Are Modern Economies Dynamically Efficient?

Abel, Mankiw, Summers, and Zeckhauser (1989) ^[4] develop a criterion for addressing dynamic efficiency and apply this model to the United States and other OECD countries, suggesting that these countries are indeed dynamically efficient.

Notes

^ Joseph E Stiglitz and Carl E Walsh, Economics (London, WW Norton, 4th Ed, 2006) Glossary A-3
^ Sims, Eric. "Intermediate Macroeconomics: Economic Growth and the Solow Model" (PDF). Retrieved 24 July 2014.
^ Romer, David (2012). Advanced Macroeconomics (4 ed.). {{cite book}}: |access-date= requires |url= (help)
^ Abel, Andrew; Mankiw, Gregory; Summers, Lawrence; Zeckhauser, Richard (1989). "Assessing Dynamic Efficiency: Theory and Evidence". Review of Economic Studies. 56 (1): 1-20. {{cite journal}}: |access-date= requires |url= (help)

[1] Joseph E Stiglitz and Carl E Walsh, Economics (London, WW Norton, 4th Ed, 2006) Glossary A-3

[2] Sims, Eric. "Intermediate Macroeconomics: Economic Growth and the Solow Model" (PDF). Retrieved 24 July 2014.

[3] Romer, David (2012). Advanced Macroeconomics (4 ed.). {{cite book}}: |access-date= requires |url= (help)

[4] Abel, Andrew; Mankiw, Gregory; Summers, Lawrence; Zeckhauser, Richard (1989). "Assessing Dynamic Efficiency: Theory and Evidence". Review of Economic Studies. 56 (1): 1-20. {{cite journal}}: |access-date= requires |url= (help)

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